CPI expected to show impact of rising energy prices

WASHINGTON (MarketWatch) -- With energy prices bouncing higher during the month, consumer prices probably rose in December for the first time since August, analysts said ahead of Thursday's consumer price index release.

The CPI probably rose by a hefty 0.5% in December, economists surveyed by MarketWatch predicted, compared with a flat reading in November and 0.5% declines in both September and October.

The numbers will be released at 8:30 a.m. Eastern time at the Labor Department.

The CPI story has been about energy prices for the past few months. When energy prices were falling 14% between August and November, the CPI declined by 1%. But with energy prices rising by an estimated seasonally adjusted 4.5% in December, the CPI is heading higher again.

Federal Reserve officials wouldn't welcome the higher CPI, but they wouldn't panic either. They are more focused on core inflation rates, which exclude food and energy prices, precisely because they are so volatile from month to month.

Excluding food and energy, consumer prices likely increased 0.2%, economists said. That would be the highest core rate since September, and would probably keep the year-over-year gain in core prices at 2.6%, still too high for the Fed's comfort but lower than the 2.9% year-over-year gain seen in September.

"The key issue in core CPI is whether goods prices, particularly for motor vehicles and apparel, will continue to fall sharply as they did the previous two months," wrote Drew Matus, an economist for Lehman Bros., in his daily note to clients.

The core rate was held down in October and November by falling vehicle prices. The government data have had a particularly hard time recently in adjusting prices for model-year improvements and for seasonal factors. Expect vehicle prices to rebound higher in December.

Shelter costs, which represent about 32% of the CPI, are expected to rise 0.4% in December, according to David Greenlaw, an economist for Morgan Stanley.

Maury Harris, chief U.S. economist for UBS, said the rise in shelter costs is not due to actual higher prices, but to a quirk in the way the government calculates the data from equivalent rents, not from home prices and mortgage costs.

"The acceleration in rents appears to be a byproduct of the weakening in home buying, as indicated by a sharp weakening in home prices (with more potential homeowners opting to rent than buy), rather than true overheating," Harris wrote in his weekly note. "The pace in rents appears to have peaked, however."

The increase in shelter costs has been responsible for the acceleration in the core CPI. Excluding shelter, the core CPI has risen at a 1.5% annual rate in 2006, down from 1.8% in 2005, Harris said.

The Fed

The Fed prefers a separate measure of core consumer inflation released by the Commerce Department at the end of the month. By that measure -- the core personal consumption expenditure price index -- core inflation is up 2.2% in the past year, just above the Fed's unofficial 1% to 2% comfort zone.

The core PCE uses the same raw data that goes into the CPI, but with a slightly different methodology.

Economists are almost unanimous in their belief that the Fed will hold overnight rates steady at 5.25% at the meeting on Jan. 30 and 31, and probably at the March 21 meeting as well.

The current level of interest rates is "well-positioned" to keep the economy "middling" along and to bring down inflation over time, San Francisco Federal Reserve Bank President Janet Yellen said Wednesday.

Private-sector economists tend to agree with Yellen, especially about growth remaining above water. As for inflation coming down soon, most economists have their doubts.

"It is probably too early to see a sustained cyclical downshift in core inflation," wrote Ian Shepherdson, chief U.S. economist for High Frequency Economics, in his daily note to clients. "It usually lags the economic cycle by about a year."

Rex
Nutting

Rex Nutting is a columnist and MarketWatch's international commentary editor, based in Washington. Follow him on Twitter @RexNutting.

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